Nucor (NUE) is a long term outperformer in a very volatile industry. The company has invested huge sums into new plants, equipment and M&A over the past decade. These investments are now starting to pay off with the steel market showing a real recovery.
The new political leadership seems eager to benefit domestic producers like Nucor, and the company is benefiting from its integrated business model and investments into higher value-added products, so the outlook for future earnings looks bright.
While it is true that the market has appreciated the improved earnings picture, shares are up a relatively modest 20% over the past year following a recent 12% correction. If shares retest the mid-fifties again, I will become an eager buyer, as Nucor has a great long term track record combined with good prospects and a fair valuation.
A Steady Outperformer
Nucor is a structural outperformer in a cyclical steel industry as a result of its status as a low cost producer, its strong market positions, its commercial excellence and its focus on higher-value-added products.
Coming out of the 2009 crisis, Nucor made heavy investments in the business that still have not really boosted results to this day, though Nucor is benefiting from its vertically integrated business model. Past investments to create a strong business are becoming visible today as industry conditions improve amidst growth, hopes about infrastructure spending plans and actions being taken by the new administration on dumped steel imports, which still make up a quarter of the US market.
Despite the focus on operational excellence, low costs, diversification and prudent financial management, Nucor is not immune to its environment. Following softer years in 2000-2004 the company delivered on record earnings in 2005-2008, and that was followed by the harsh realities of 2009. The recovery was modest, as real momentum for the steel industry only started to become evident in the tangible results from 2014-2015 onward.
Part of the success of Nucor stems from structural capital investments into higher performing factories and equipment, as well as bolt-on dealmaking in high-value-added activities. Over the past decade Nucor has invested roughly $7 billion into capital projects, offset by similar depreciation & amortization charges. At the same time, the company announced roughly $7 billion worth of deals, including some larger ones back in 2007/2008. With M&A and capital spending outpacing depreciation charges by $7 billion over this time period, these investments have eaten a substantial portion of the $10 billion in profits that have been reported over the past decade.
The company has recently become more active with regard to dealmaking again, focusing on smaller but higher-value-added players. Recent deals include the 2016 purchase of Independence Tube for $435 million. Other deals include the $130 million purchase of Southland Tube and $335 million purchase of Republic Conduit. The $900 million spending spree boosts the overall production capacity of the company by some 4%, but more important grows the exposure to higher-value-added products. These deals were taking place at multiples of 6-8 times average EBITDA being generated over a time window of a few years.
In comparison, Nucor is currently valued at roughly $22 billion on an enterprise basis. If the first quarter performance is indicative of the performance for the rest of 2017, the company itself trades at roughly 7 times adjusted EBITDA. Of course, Nucor´s EBITDA numbers for both 2015 and 2016 are much lower, suggesting that the recent deals have been taking place at very reasonable multiples.
What About The Valuation?
For a steel company, Nucor is posting surprisingly resilient numbers. Shares jumped from levels of $10 in the early 2000s to a peak of $80 in 2008, as commodity prices were peaking, which supported a $6 earnings per share number that year. Since then, shares have traded in a $30-$60 range, which is actually a pretty narrow range for a steel company. Shares are now trading at the higher end of this range, following a recent high of $68 in the aftermath of the Trump-induced/reflation rally.
Amidst improving conditions Nucor is on track to post sales of $20 billion this year, which is a bit below the 2008 peak of $23.7 billion, but far above the 2009 lows of $11.2 billion. While the company is highly cyclical, Nucor has remained profitable throughout the economic cycle. Operating margins have ranged between 1% in 2009 and levels in the high-teens during the boom times, having averaged at roughly 8% of sales over the past decade. That said, most of these earnings were driven by the boom times of 2005-2008. Margins have come in at levels in the mid single digits until recent years. Operating earnings improved to $1.47 billion last year, with margins coming in at 9% $16.2 billion in sales.
2017 started on a very strong note: revenues jumped by 30% to $4.82 billion amidst a 21% increase in prices, with shipments increasing by 9% and sales tons up 7%. The increase in prices and operating leverage resulted in a huge boom in earnings. Operating earnings improved to $593 million, which is equivalent to 12.3% of sales. Current margins have more than doubled compared to levels reported last year. Sales growth, strong operating leverage and lower earnings attributable to minority interest allowed earnings to quadruple to $357 million. The $1.11 earnings per share number is the highest quarterly profit number reported since 2008.
The balance sheet remains in excellent shape: the company holds $1.71 billion in cash and equivalents, with debt totaling some $4.39 billion, for a net debt load of $2.7 billion. If the performance of the first quarter can be annualized, EBITDA surpasses $3 billion a year which suggests that leverage ratios come in below 1 time.
Even better, management anticipates that the second quarter results will be even better than the first quarter – which bodes well for the full year results. Management attributes the strong operational momentum to a resilient automotive market and strength in energy markets (as the rig count has doubled), as well as improved construction in non-residential markets.
I believe that Nucor is worth owning. The company is differentiating from its peers by making better investments and operating with a better balance sheet, and it is moving into higher-value-added products and market segments.
I like this strategy as huge multi-billion investments of the past are now really starting to pay off, with earnings power probably seen anywhere between $4 and $5 per share this year. While shares have been doing well over the past year, a 20% return is not that excessive as the overall market is up by double digit percentages as well over the past year. At the same time, both the tangible results and prospects for Nucor have meaningfully improved.
The valuation remains very reasonable. Nucor trades at 1.1 times sales, just 10% above the 10 year average of 1 times. Based on EBITDA and earnings multiples the valuation is actually very cheap and leverage is low. Investors might even potentially look forward to receiving a special dividend. All of this makes me a buyer on dips. I would start a position in the mid-fifties – and would be glad to average down.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.